G20 leaders met at the London Summit against a backdrop of rapidly shrinking global capital and trade flows. This column – written by a senior economist working within the UK Cabinet Office – argues that the proposals agreed at the London Summit provide much needed support to the global economic system, and to emerging and developing economies in particular, and are a step towards the creation of more effective and credible institutions for the future.

The scale and severity of the current economic and financial crisis has highlighted the need for credible and effective global financial institutions to mitigate the impact of the crisis and to put the world economy on the path to recovery.

G20 leaders met against a backdrop of shrinking global capital and trade flows and committed to strengthening international financial institutions (IFI) by:

increasing resources;

transforming lending instruments; and

reforming mandate and governance arrangements.

Proposals agreed at the London Summit provide much needed support to the global economic system, and to emerging and developing economies in particular, and are a step towards the creation of more effective and credible institutions for the future.

Resources

The current crisis has seen a sharp withdrawal of private capital to emerging and developing economies. The World Bank estimates that developing countries face a financing gap in their external financing needs of between $268-700 billion (including for trade finance). Given the deterioration in global economic growth prospects since the report was produced, the scale of need is likely to be in the upper end of the range.

Developing countries are also likely to face financing shortfalls as a result of the decline in economic activity. Reduced exports, decreased foreign direct investment, declining tax revenues, and a fall in foreign remittances are likely to further limit developing countries' ability to respond to the crisis.

As highlighted in Vox discussions, IFI resources are inadequate to support developing countries through the downturn. With these economies forecast to account for all global economic growth in 2009 and 2010, sustaining demand in emerging and developing economies is essential to prevent a further deterioration in growth prospects and restore global economic growth.

In response, G20 leaders committed to making available over $1 trillion in additional resources through IFIs (see table 1).

Table 1: Breakdown of additional resources made available through IFIs

Proposal

Resources

Trebling IMF resources to $750 billion – immediately through bilateral loans and market borrowing and through expanded and enlarged NAB and quota reform in the longer-term

$500 billion

A new SDR allocation – using existing quota shares

$250 billion

($91 billion to emerging and developing economies, $19 billion to low income countries)

Increased MDB lending – through capital increases and more effective use of MDB balance sheets

at least $100 billion over 2009, 2010, and 2011

Increasing availability of trade finance – through existing capacity, additional resources, and more effective use of existing financing

$250 billion over 2009 and 2010

They agreed to increase IMF resources - initially funded through bilateral borrowing, to be then incorporated into an expanded and enlarged New Arrangements to Borrow of up to $500 billion. In 2008, Japan had already committed to loaning the IMF $100 billion, and in the run up to the Summit, EU member states committed to provide another $100 billion. The IMF was also urged to consider market borrowing to raise required resources in the short-term and quota reform to put its finances on a more long-term sustainable footing. Finally, consistent with the Vox consensus, G20 leaders agreed to a new SDR allocation of $250 billion - providing an additional $91 billion in liquidity to emerging and developing economies (approximately $19 billion allocated to low income countries).

To meet the broader development needs, leaders urged MDBs to provide at least $100 billion in additional lending over the next three years - through capital increases and more effective use of their balance sheets. To this end, they supported a 200% capital increase for the Asian Development Bank and reviews of capital adequacy at other MDBs. They also supported full use of MDB balance sheets to increase capacity for lending to meet crisis needs and more effective leveraging of private capital through the use of guarantees, bond insurance and bridging finance.

The importance of trade finance in facilitating trade flows was reflected in the pledge by leaders to make available $250 billion in trade finance over the next two years - through a combination of additional resources and more effective use of existing financing. As part of this effort, they urged IFC's new Global Trade and Liquidity Pool to provide up to $50 billion in trade financing over the next three years, based on voluntary bilateral contributions and significant co-financing from the private sector.

These proposals make available significant additional resources to emerging and developing economies to deal with the crisis - over 4% of emerging and developing economy GDP in 2009.

Lending

Along with an increase in resources, it is important that IFIs have appropriate lending mechanisms in place to provide timely and effective financing to meet the needs of emerging and developing economies.

Many emerging and developing economies are being affected by the crisis through no fault of their own. Emerging economies with relatively sound economic polices and fundamentals have lost access to private capital markets. Low income countries with less robust economic and financial systems now face millions of people going into poverty as a direct consequence of the crisis. Meeting the needs of countries with varying economic strength and in varying stages of development requires a rethink of IFI lending instruments - something highlighted in Vox discussions around the need for less conditionality in IMF lending.

In response, the IMF is implementing a series of reforms to strengthen its lending framework, including reforming conditionality to be ex-ante rather than ex-post where appropriate, and softening the terms of IMF-supported structural reform programmes. To this end, the IMF has proposed a new precautionary credit facility - the Flexible Credit Line - available to countries with strong fundamentals, policies, and track records of policy implementation that aims to overcome the stigma problems associated with IMF ending. It has also proposed reforms to its existing nonconcessional facilities.

G20 leaders at the London Summit welcomed the proposed reform of IMF lending instruments, including the FCL and Mexico's decision to sign up to it, and called on the IMF to go further in ensuring that its surveillance and lending facilities address not just the symptoms but the underlying causes of countries' balance of payment crises.

Leaders also urged the IFIs to make available greater resources to low income countries. Doubling IMF's concessional lending capacity for low income countries - through the Exogenous Shock Facility and Poverty Reduction and Growth Facility - along with a doubling of access limits could make available $10 billion or more in additional financing to low income countries over the next few years. They urged the IMF to bring forward proposals for using proceeds from agreed gold sales to support lending to low income countries. In addition, leaders agreed several proposals to increase MDB lending to low income countries, including contributions to support the World Bank's Vulnerability Framework and allowing some low income countries with sustainable debt positions temporary access to non-concessional World Bank lending.

Overall, the combination of increasing resources and reforming lending IFI mechanisms will make available an additional $49 billion to low income countries over the next several years.

Mandate and Governance

Finally, the ability of IFIs to make effective interventions depends on their credibility and acceptance among countries they are seeking to help. IFI mandate and governance reform was the subject of much discussion on Vox, with many arguing for the need for expedited and fundamental reform.

One of the lessons of the current crisis is the need for more effective surveillance of global macroeconomic risks. To that end, G20 leaders agreed that the Financial Stability Forum (renamed the Financial Stability Board) work with the IMF to provide early warning of systemic risks.

On governance reform, G20 leaders agreed on the need to ensure that IFI governance structures reflect the realities of the world economy today. They committed to implement previously agreed reforms and accelerate future reforms, with the next IMF quota review to be completed by 2011 and World Bank voice and representation reform to be completed by 2010. Leaders also agreed to the merit-based selection of the heads and senior leadership of the IMF and World Bank.

Recognising the need for improved strategic oversight and decision-making, leaders have also asked the IMF to consider greater involvement of the Fund's Governors in providing strategic direction to the IMF and increasing its accountability.

Overall, G20 leaders were clear on the need for comprehensive reform of IFI mandates, scope, and governance to reflect changes in the world economy, including the need for greater voice and representation for emerging and developing economies. The UK chair, working with G20 Finance Ministers, has agreed to report back to the next meeting of G20 leaders on proposals for further governance and mandate reform to improve responsiveness and adaptability of the IFIs. These and other proposals will be taken forward at the next G20 summit and in the context of the accelerated reform process agreed by leaders.